China should dial R for Rajan

Illustration for the article "China should dial R for Rajan"

PHOTO: The Straits Times

Among the most startling pieces of news on China's economy lately was one citing investor Kyle Bass whose firm, Hayman Capital Management, reckons that the mainland's liquid foreign reserves are only US$2.2 trillion (S$3 trillion) at most, whereas the People's Bank of China (PBOC) maintains it is a trillion dollars more.

Even the PBOC's figure of US$3.23 trillion in reserves is a huge dip from the US$4 trillion China held less than a year ago, underscoring how quickly money is leaving China. Bloomberg Intelligence thinks that came to about a trillion dollars last year. Those flows have slowed a bit lately, true, but at more than US$3 billion a day it means that a fortnight's capital flight from the mainland equals as much as the entire money that fled Indonesia in the 1997-99 period, when its economy was devastated by the Asian financial crisis.

Even after adjusting for the relative size of their economies, this is serious stuff.

"China's back is completely up against the wall today, which is one of the primary reasons the government is hypersensitive to any comments regarding its reserve levels or a hard landing," Mr Bass reportedly wrote to clients.

There is also worry that, as China sends capital overseas for acquisitions, many of the state- owned companies in the vanguard are dragging along massive debt portfolios. This could, if the climate turns more sour, curdle economies even beyond Asia's shores and hurt even Western banks, some of whom have lent to these entities only because of the sturdy backing of the state they are said to enjoy.

As the saying goes, there is a reason why debt is called leverage: it amplifies the effects in both directions. Some analysts think that China may need all its reserves just to fix its bad debt problem.

Hedge fund managers like Mr Bass and Mr George Soros do profit when they make massive bets on a nation's currency or stocks, then put out word that helps events move towards the conclusion they had prophesied. These things are par for the course. However, regardless of whether the punters will be proved right or not, Beijing clearly has a problem on its hands, and the rest of Asia is not unaffected either. Last month, investors pulled nearly US$300 million - more than 5 per cent - from one of the biggest Asia funds, Templeton Asia Growth Fund run by the legendary Mark Mobius. Other investors are using the China factor to even short Singapore's platinum-plated banks.

While all the excitement now surrounds the financial markets, it must be considered that if the economic conditions on the mainland are worsening - see the dramatic fall in imports which caused Singapore's shipments to China to fall by a quarter in January - it is a matter of time before people's livelihood gets affected.

And that brings the next big China worry - political instability.

CONFOUNDING MOVES

The wide powers amassed by President Xi Jinping since taking charge in 2012, his proclivity to encroach on economic policy - traditionally the Premier's domain - and his growing fondness for being described as the "core leader" build up to a situation where he may not have too many to share the blame with, if things do go badly wrong. Few will care to point out then that most of the mess is inherited from at least two generations of previous leadership. At the very least, as China prepares to take over the presidency of the Group of 20, it is not a happy position for the President.

Yet, several indicators suggest the real economy may not nearly be as tepid as the hedge-fund-wallahs would like us to believe. The residential housing market, which so weighed things down the past two years, has begun to stir. Consumer spending, and services, are strong. Indeed, the economy may have gathered a bit of steam in late 2015. Even so, the hard-landing theorists will not go away. Makes you wonder if much of this is because China's economic managers are making so many confounding manoeuvres that it looks like they have lost their way.

In June, when the ridiculous run-up in stocks reversed, Beijing ordered several state-run firms to step in and buy up stocks in order to put a floor under the market. Then, when it came time to unwind those stocks, it imposed a "circuit breaker" that would suspend trading if shares fell more than 5 per cent in a day - only causing investors to try dumping the shares in a hurry. The move in August to make the yuan more market-determined, as Beijing sought to push its currency into the International Monetary Fund's (IMF) exclusive band that makes up the Special Drawing Rights, backfired because it came with a devaluation - quickly interpreted by most people as prompted by worry about falling exports.

To cap it all, December's move to de-peg from the US dollar in favour of a wider basket of currencies, which caused the yuan to fall to levels closer to the one judged by the market as appropriate, now seems to have been reversed. Beijing, it seems, wants to re-peg to the dollar to take advantage of its sliding value. How else to interpret Monday's move to guide the yuan higher, and by a central bank head who had been silent for months?

China is surely not short of talent but it does appear that the professionals are not being allowed to do their job. Instead, it seems that political priorities dominate.

This is where the Asian giant could take a leaf from the playbook of the other giant, India, that has now taken charge of the label of being the world's fastest-growing major economy.

OVER IN INDIA

Several of India's state-owned banks are in a mess and there are many who think that sleight of hand contributes to the impressive growth numbers it has been reporting. The real economy, it is generally agreed, is far more sluggish. But what it has is a visible - and when he chooses, voluble - central bank governor whose credibility and reputation span the globe. It was Dr Raghuram Rajan who, as chief economist of the IMF, so accurately foretold the 2008 global financial crisis. Now, as governor of the Reserve Bank of India, Dr Rajan has stood firm against his finance minister's entreaties for lower interest rates to spur growth, only cutting them when he deemed it was appropriate to do so. Interestingly, part of the scepticism of the way India's growth is being calculated has come from Dr Rajan himself, not hedge-fund managers with huge open positions. Last month, for instance, he said in a speech that "we have to be a little careful about how we count GDP".

This must surely infuriate Prime Minister Narendra Modi, whose political muscularity is in part built on promises of rolling in the good times. But Mr Modi knows he cannot touch the man and even makes nice with him; indeed, on the economy at least, he must be aware that Dr Rajan's credibility exceeds his own.

More importantly, it is his actions that count. Dr Rajan has lashed the state lenders into accounting swiftly for the souring loans on their books. Last week, Indian bank stocks fell after the State Bank of India, the largest lender, said profits fell by two-thirds last quarter because it had to set aside more to account for unrecoverable loans. Other state-owned banks are wrestling with similar issues as they rush to meet the March 2017 deadline set by the governor to clean up their acts.

Thanks to him, and a vigilant media, India's problems are more or less in public view. More importantly, there is a perception that they are being fixed. Thus, when a rating agency like Crisil, a division of Standard & Poor's, optimistically forecast last week that India's GDP growth would accelerate to 7.9 per cent in the year to March 2017, not too many eyebrows were raised. India gets the benefit of the doubt. China does not.

What China needs are credible voices to explain its policies to the world. Its central bank chief, Mr Zhou Xiaochuan, is a well-respected figure, but it is not clear if he is being allowed to do his job to the level of his expertise. Beijing could even consider quietly inviting India's Dr Rajan over and see what advice he has to offer. After all, as the IMF chief economist, there would not have been much that Dr Rajan could not have known about China's economy, or, continued to have access to.

If Dr Rajan is convinced that the No. 2 economy is in better shape than the doomsayers like to project, he could be encouraged to drop a few well-chosen words to the media. They would reverberate around the world and have a salutary effect on those heading for the China exits. If, on the other hand, he judges the situation is indeed dire, he can be counted on to keep silent.

It may be worth a try. After all, this is no longer about a small kitchen fire.

velloor@sph.com.sg

This article was first published on February 19, 2016. Get a copy of The Straits Times or go to straitstimes.com for more stories.